3 Ways Advisors Can Evaluate Funds With ESG Factors

How sustainable investing solutions can help your clients better understand their portfolios

Aug 10, 2018

Maggie Stafford, Morningstar Research
Services LLC

Sustainable investing can take many forms.

For instance, some investors seek to align their investments with
their values. Others use environmental, social, and corporate
governance (ESG) criteria to evaluate investment options, lower risk,
or potentially enhance returns. Some seek to make environmental or
societal impact alongside financial return with their investments. And
still, many investors may want use each of these approaches within
their portfolios.

Here are three approaches and tools that advisors can use with
clients to have more informed conversations about sustainable investing:

Consider aligning investments with your clients’
values: Some investors want to know what their exposure is
to specific types of products, services, or business activities that
they may find to be offensive or controversial. Others may want to
completely exclude companies engaged in these areas based on their
values or preferences. This involvement information can be difficult
for advisors to obtain consistently, much less display in a
meaningful way to support client conversations. To meet this growing
need, we created Morningstar Portfolio Product Involvement Metrics.
These holdings-based calculations use company-level research from
Sustainalytics, a leading ESG research firm, to surface a
portfolio's exposure to 15 areas, including alcohol, tobacco,
gambling, small arms, and thermal coal. Investors can compare these
exposure levels to the portfolio’s peers to help investors make
decisions about their exposure levels and alternative investment
options.

Using ESG factors to mitigate risk and potentially
strengthen returns: Advisors are interested in achieving
the best investment outcomes for their clients. Mitigating their
exposure to risk by identifying companies with good governance and
effective policies is a practical approach to implementing ESG
investing. Rating systems like the Morningstar Sustainability
RatingTM can be a good starting point for many
advisors to assess how a portfolio manages its ESG risks and
opportunities. The rating is based on company-level ESG research
from Sustainalytics. This research offers an additional layer of
information beyond traditional financial metrics. It provides
details about a company’s preparedness, disclosure, and performance
on ESG issues relevant to their business for example: data privacy
issues for a software company, or labor standards for a supply chain
company. It also assesses any major incidents that have
environmental or societal impact and pose risks to the company. The Sustainability
Rating aggregates this information at the portfolio level. The
rating and supporting metrics can be used for peer comparison, as
part of a broader investment selection process, or for ongoing
portfolio monitoring.

Investing with impact: We’ve seen a growing
interest from investors who want to quantify or measure the impact
of their investments. Investors may be able to achieve a more
measurable impact by focusing on a specific theme such as gender
diversity, clean technology, or solar power. There are impact funds
that state these thematic or sector specific objectives by
prospectus. And there are impact-oriented metrics that assess how
any portfolio is managing the risks posed by climate change and
involvement in positive environmental impact areas. We recently
developed the Morningstar® Low Carbon DesignationTM for
funds that incorporates both carbon risk levels and fossil fuel
involvement, giving investors a way to more easily identify
low-carbon funds. Within the same set of metrics, we also provide
insights into involvement areas like green transportation and
renewable energy for investors interested in more proactive measures
that companies are taking to manage carbon risk.

​Please see below for important disclosure.

Learn more about how to align investments with
your clients’ values using our ESG data and research.

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